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Noise, Information, and the Favorite-Longshot Bias

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  • Marco Ottaviani

    (London Business School)

  • Peter Norman Sørensen

    (Department of Economics, University of Copenhagen)

Abstract

According to the favorite-longshot bias, longshots are overbet relative to favorites. We propose an explanation for this bias (and its reverse) based on an equilibrium model of informed betting in parimutuel markets. The bias arises because bettors take positions without knowing the positions simultaneously taken by other privately informed bettors. The direction and the extent of the bias depend on the amount of private information relative to noise present in the market. With realistic ex-post noise and ex-ante asymmetries, our model replicates the main qualitative features of expected returns observed in horse races.

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Bibliographic Info

Paper provided by University of Copenhagen. Department of Economics. Finance Research Unit in its series FRU Working Papers with number 2006/04.

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Length: 25 pages
Date of creation: May 2006
Date of revision:
Handle: RePEc:kud:kuiefr:200604

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Keywords: parimutuel betting; favorite-longshot bias; private information; noise; lotteries;

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